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    1

    The root-causes of the

    Greek sovereign debt crisis

    Basil Manessiotis

    paper presented at the 2nd Bank of Greece workshop onthe economies of Eastern European and Mediterranean

    countries

    Athens, 6 May 2011

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    2

    Introduction

    To better understand the current sovereign debt crisis inGreece, a longer view is warranted

    The 20 year period 1989-2009 is bounded by two majorfiscal crises in Greece: the 1989-1993 crisis, and the ongoing crisis.

    In both crises deficits exceeded 15,0% of GDP.

    In between, Greece entered the Economic and Monetary

    Union and adopted the Euro

    To facilitate discussion the 20 year period will be dividedinto two parts: the 1989-1999 period, and the 2000-2009 period.

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    3

    1989-1999: securing EMU membership

    The 1989-1993 sub-period: Macroeconomic developments

    Weak economic activity (1.2% average growth)

    Very high inflation (16.8% annual average) Very high real and nominal interest rates

    Low fixed investment (1.5% annual average)

    Fiscal developments Very high general government deficits (13.6% of GDP average)

    The 1990 deficit reached 15.9% of GDP

    Primary deficit averaged 4.3% of GDP Fast accumulation of debt

    Debt ratio increased from 69.0% of GDP in 1989 to 110.1% of GDP in1993

    Other reasons for debt accumulation Very high interest payments

    From 6.8% of GDP in 1989 to 11.4% of GDP in 1993

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    TABLE 1Selected Macroeconomic Indicators

    (annual average rate)

    -5,2 (-5,7)* -8,3 (-9,1)*

    0,6 (0,7)* -2,9 (-3,2)*

    45,5 (49,9)* 47,5 (52,1)*

    40,3 (44,2)* 39,1 (42,7)*

    101,0 (110,7)* 109,7 (120,2)*109,0

    *Numbers in parentheses show respective values prior to the GDP revision by 9,6%, which covers only the period 2000-2009.

    Real GDP growth

    Fixed investment growth

    Total general government revenue (% of GDP)

    Current Account deficit (% of GDP)

    Total general government expenditure (% of GDP)

    Inflation (CPI)

    General Government debt (% of GDP)

    1989-1993

    73,7

    Primary Deficit (-) or Surplus (+) (% of GDP)

    16,8

    General Government deficit (% of GDP)

    2005-2009

    1,2 2,8 4,5 2,0

    2000-20041994-1999

    -1,9

    3,0

    -2,6 -3,0 -6,8 -11,9

    48,7 48,7

    35,1

    1,5 6,96,1

    -13,6 -7,0

    3,3

    4,0

    41,5

    -4,3

    6,8

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    Diagram 1

    Real GDP growth

    -3

    -2

    -1

    0

    1

    2

    3

    4

    5

    6

    7

    1989

    1990

    1991

    1992

    1993

    1994

    1995

    1996

    1997

    1998

    1999

    2000

    2001

    2002

    2003

    2004

    2005

    2006

    2007

    2008

    2009

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    Diagram 2Elections and General Government Deficit

    (% of GDP)

    0

    2

    4

    6

    8

    10

    12

    14

    16

    18

    1980

    1981

    1982

    1983

    1984

    1985

    1986

    1987

    1988

    1989

    1990

    1991

    1992

    1993

    1994

    1995

    1996

    1997

    1998

    1999

    2000

    2001

    2002

    2003

    2004

    2005

    2006

    2007

    2008

    2009

    %o

    fG

    DP Elections

    Elections

    Elections

    Elections

    Elections

    Elections

    Elections

    Elections

    Elections

    Elections

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    Securing EMU membership: 1994-1999

    Fiscal developments Tight fiscal policy stance

    General government deficit declined from 13.6% in 1993 to 1.8% in 1999

    (although later it was revised to 3.4%) Consolidation exceeded 10 p.p. of GDP

    Primary surpluses appeared, reaching 4.9% in 1999.

    Interest payments reached an alarming 12.7% of GDP in 1995 and then

    declined to 8.4% of GDP in 1999

    The quality of fiscal consolidation Composition of fiscal consolidation was lacking

    Based on tax increases and falling interest payments

    Primary expenditure increased from 36.2% (1994) to 39.9% of GDP(1999)

    Personnel expenditure rising every year, exceeding budget targets 1995-1998: the central government wage bill increased by 70.7%

    Pensioners Solidarity Allowance was introduced in 1997

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    Diagram 3Primary General Government Deficit (% of GDP)

    -6,0

    -4,0

    -2,0

    0,0

    2,0

    4,0

    6,0

    8,0

    10,0

    12,0

    1988

    1989

    1990

    1991

    1992

    1993

    1994

    1995

    1996

    1997

    1998

    1999

    2000

    2001

    2002

    2003

    2004

    2005

    2006

    2007

    2008

    2009

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    Diagram 4General Government interest payments

    (EDP definition)(% of GDP)

    0,0

    2,0

    4,0

    6,0

    8,0

    10,0

    12,0

    14,0

    1979

    1980

    1981

    1982

    1983

    1984

    1985

    1986

    1987

    1988

    1989

    1990

    1991

    1992

    1993

    1994

    1995

    1996

    1997

    1998

    1999

    2000

    2001

    2002

    2003

    2004

    2005

    2006

    2007

    2008

    2009

    YEAR

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    Securing EMU membership: 1994-1999

    Taking all these into account, fiscal consolidation was notsustainable

    Fiscal policy inside the Euro-zone should have been More active, to correct macroeconomic imbalances and asymmetric

    socks More flexible and autonomous More disciplined Tax competition, migration of tax bases

    Greece entered EMU with two fundamental weaknesses The debt-to-GDP ratio was too high, exceeding 100% of GDP.

    Adversely affects growth prospects and sets severe limitations onfiscal policy The institutional fiscal framework which determines fiscal outcomes

    was extremely weak (not-existing) Budget preparation Numerical fiscal rules Independent assessment

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    Diagram 5General Government gross consolidated debt (Maastricht definition)

    (% of GDP)

    0,0

    20,0

    40,0

    60,0

    80,0

    100,0

    120,0

    140,0

    160,0

    1979

    1980

    1981

    1982

    1983

    1984

    1985

    1986

    1987

    1988

    1989

    1990

    1991

    1992

    1993

    1994

    1995

    1996

    1997

    1998

    1999

    2000

    2001

    2002

    2003

    2004

    2005

    2006

    2007

    2008

    2009

    2

    010**

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    Inside the euro-zone

    The traps could have been avoided by: Increased fiscal discipline

    Increasing the competitiveness of the economy

    Greece did neither of them

    Macroeconomic developments in the 2000-2004 sub-period

    Strong economic activity (4.5% real growth) Very low inflation (3.3% annually) but higher by 1.5 pp than the EZ

    High consumption, fuelled by rapid credit expansion

    High investment growth (6.9% average)

    Inevitable easing of monetary conditions Sharp decline in interest rates (end 1999-end 2006)

    Elimination of credit restrictions Reduction of reserve requirements from 12% to 2%

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    Inside the euro-zone : 2000-2004

    Fiscal developments Fiscal policy should have offset the loosening of monetary policy On the contrary, fiscal policy loosened progressively Significant tax cuts from the first year Primary surplus declined and as of 2003 turned into deficit Repeated revenue short falls and expenditure overruns

    Public debt remained broadly stable Despite extremely favourable conditions the debt-to-GDP ratio

    remained broadly stable (high GDP growth, historically low interestrates, primary surpluses [up to 2003], revenue from privatizations)

    Significant fiscal deterioration in 2003 and especially in2004, despite the fact that in 2004 Greece was under theEDP

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    Inside the euro-zone : 2000-2004

    Greece was subjected to the Excessive Deficit Procedure(EDP) in mid 2004 Immediately after the March elections, Greek authorities notified

    Eurostat that 2003 deficit was 2.95% of GDP. Eurostat came to Athens on 26-27 April. The 2003 deficit was

    revised to 3.2% In May the Commission initiated the EDP against Greece

    On 5th July 2004 the ECOFIN Council decided that Greece was inexcessive deficit

    Greece was asked: To put an end to the excessive deficit by end 2005 at the latest To take effective action and submit a package of measures by

    November 5th

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    Inside the euro-zone : 2000-2004

    Insufficient measures Commission: Greece did not take effective action

    Over and above fiscal revisions and slippages related to theOlympic Games the fiscal policy stance further worsened in asituation of buoyant economic activity

    Thus Greece was moved to Art. 104, par.9

    Greece took additional tax measures on 29 March 2005

    (Updated Stability and Growth Programme) As a result of the fiscal audit, deficit and debt

    figures for 2000-2004 were repeatedly and

    significantly revised The fiscal revisions created uncertainty about

    the true state of Greek public finances.

    finances

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    Inside the euro-zone : 2005-2009 Fiscal developments

    Given that Greece was in the EDP, fiscal policy was given. Reducedeficit below 3.0% by end 2006

    Deficit declined to 2.6% of GDP in 2006 (later revisedseveral times to 5.3% of GDP)

    As with the 1994-1999 consolidation, the new

    consolidation was not a sustainable one Expenditure were not cut on a permanent basis In a years time deficit exceeded again the 3.0% reference value Good fiscal performance in the first semester of 2007

    On the basis of 2006 outcome, the EDP ended on June 6th

    2007

    Fiscal magnitudes deteriorated in July-August 2007

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    Diagram 6Central government cash deficit 2006-2007

    (% GDP)

    0,0

    1,0

    2,0

    3,0

    4,0

    5,0

    6,0

    Jan

    Jan-Feb

    Jan-Mar

    Ja

    n-Apr

    Jan

    -May

    Jan

    -June

    Jan-July

    Jan-Aug

    Jan

    -Sept

    Jan-Oct

    Jan-Nov

    Jan-Dec

    %g

    dp

    2006 2007

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    Inside the euro-zone : 2008

    2008 was a pivotal year GDP growth decelerated but remained positive Large deterioration in fiscal outcome

    Revenue shortfall by 1.3% of GDP (3.3 bill.euro)

    Expenditure overruns by 1.2% of GDP (3.0 bill.euro) Press reports: government gave up any effort to reign in

    waste(December 2007) IMF: the quality of expenditure adjustment in the 2008 budget falls

    short of what is needed to ensure sustainable consolidation.

    In April, Bank of Greece warned about debt dynamics

    In their Spring forecasts all international organizationsprojected a deceleration in GDP growth in Greece

    Despite continuous worsening of monthly fiscal data andmacroeconomic prospects no measures were taken.

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    Diagram 7Central government cash deficit 2007-2009

    (% GDP)

    -2,0

    0,0

    2,0

    4,0

    6,0

    8,0

    10,0

    12,0

    14,0

    16,0

    Jan

    Ja

    n-Feb

    Ja

    n-Mar

    Jan-Apr

    Ja

    n-May

    Jan-June

    Ja

    n-July

    Ja

    n-Aug

    Jan-Sept

    Ja

    n-Oct

    Ja

    n-Nov

    Ja

    n-Dec

    %g

    dp

    2007 2008 2009

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    Inside the euro-zone : 2008

    Rising spreads

    Spreads began to rise since early 2008

    5 March Triche warned Greece and Italy June, July debt issues had much higher yields

    On 1st September 2008 Standard & Poors and Fitch warned

    that unless Greece managed to contain public spending andreduce public debt, its credit rating would be lowered

    As the international crisis intensified spreads rose (10 year

    bonds) considerably

    Following the December 2008 demonstrations in Athensspreads rose again

    At this juncture Greece should have sent a strong messageto the markets

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    2009 and the Crisis

    The 2009 budget was outdated before the beginning ofthe new year By 30 January, the 2009 budget had been completely revised

    The 2009 deficit was estimated at 3.7% of GDP

    The execution of the 2009 budget went seriously off track Every single month deficit was much higher than in previous year

    Monthly data were not published (only in April and July)

    Revenue shortfall: 12,744 mill. euro or 5.4% of GDP

    Expenditure overruns: 6,176 mill. euro or 2.6% of GDP

    Deficit 30,102 mill. euro or 12.5% of GDP

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    2009 and the Crisis

    On 27th April Greece was subjected again to the EDP, on thebasis of 2007 and 2008 deficits The Commission clearly stated that these deficits were structural and

    were not due to the international crisis

    Greece was asked to correct the excessive deficit situation bythe end of 2010. In 20 months

    Greece was given 7 months time to submit measures to theCommission (27 October 2009)

    Commission is responsible for this

    Insufficient tax measures taken reluctantly in late June 2009

    The package of measures for EDP was never prepared

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    The crisis

    The last opportunity to send a strong message to themarkets was in the aftermath of the October election

    On 22 October the new deficit estimates were published byEurostat (12.5% of GDP)

    The same day Fitch downgraded Greece

    The 3.6% of GDP deficit reduction provided by the 2010

    budget did not satisfy markets

    Sovereign bonds downgraded again on 8,16 and 22

    December by Fitch, S&P and Moodys respectively

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    The crisis

    In the Updated SGP the decline in deficit was envisaged to4.0 % of GDP

    On 26th January 2010 spreads were at 369 pb

    Significant fiscal measures taken on 9th February and 4th

    March did not appease the markets

    A new round of downgrading in April 2010

    April 11 Eurogroup decided to help Greece

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    Conclusions : Long term problems

    The current sovereign debt crisis has deep roots:

    1. Continuous deficits for the last 36 years

    2. High and rising public debt

    3. No systematic efforts to control expenditure or contain tax evasion

    4. The three fiscal consolidations (1986-1987, 1994-1999 and 2005-2006)were not sustainable

    5. Continuous worsening of competitiveness after EMU entry

    6. Greece entered EMU without adequate preparation and fell into bothtraps: the debt trap and the competitiveness trap

    7. The magnitude and the frequency of the fiscal data revisions dealt aserious blow to the countrys credibility

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    2008-2009 developments and the crisis

    1. Plenty of warnings since the beginning of 2008. Plenty of time to takemeasures

    2. Huge expenditure overruns and revenue short falls. Unwillingness totake coherent significant fiscal measures to correct the situation

    3. Huge current account deficits

    4. When the international crisis hit the Greek economy (fall 2008), fiscaldevelopments and outlook were bleak

    5. Second EDP in April 2009, on the basis of 2007-2008 deficits. Structuralnot cyclical. Not related to the international crisis.

    6. Commission granted a very long time for Greece to take action and

    submit measures

    7. No action was taken according to EDP conclusions

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    2008-2009 developments and the crisis

    8. To deal with a debt crisis, decisive and immediate bold action isrequired. Later it would be much more difficult. A strong message to themarkets is required

    9. The October elections was the last opportunity for Greece to signal aturnabout of fiscal stance. Markets power was underestimated

    10. 20% of total debt was created in 2008-2009

    11. The international financial crisis did not cause the sovereign debtcrisis in Greece. It revealed and aggravated existing macroeconomic

    imbalances and structural fiscal problems

    12. The debt crisis adversely affected the liquidity of the banking sector inGreece, because Greek banks were cut off the interbank market

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    Thank you